By David Hooker, manager of Insight’s Inflation-linked Corporate Bond Fund
“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.” So said Ronald Reagan in 1978 at a time when the US inflation rate was in the double digits. Now, close to four decades later, the words of the former US president could come back to haunt investors, says David Hooker, manager of Insight’s Inflation-linked Corporate Bond Fund.
For Hooker, the most recent UK pricing data makes for unsettling reading. They show an inflation rate climbing to its joint highest in more than five years following a spike in the price of petrol and clothing in August. In response, the Bank of England’s (BoE) Governor Mark Carney said the possibility of a rate hike has “definitely increased”, adding: “There may need to be some adjustment of interest rates in the coming months”.
More worrying, though, is the prospect that the worst of the inflation may be yet to come. While the BoE has been fairly relaxed about the prospects for wage growth, Hooker is not so sure. In particular, he points to employment data, which suggests a build-up in the momentum towards salary increases. “For one thing,” he says, “at 4.3%, the unemployment rate is at its lowest rate since 1975. We’re also seeing data that suggests recruiting is getting harder and that job vacancies are rising. Meanwhile, labour disputes appear to be enjoying something of a renaissance right now. Even the Bank of England’s own staff went on strike earlier this year for the first time in nearly 40 years over pay.”
Figure 2: Indirect effects: there may be trouble ahead
Source: Datastream, Bank of England, June 2017. For illustrative purposes only.
For investors with inflation protection in place, says Hooker, this is perhaps not so problematic – but for those lacking a hedge against rising prices the risk is one of lacklustre returns at best or at worse, the long-term erosion of their capital base.
Even if the outlook for these factors – unemployment, job vacancies and recruitment challenges – changes, there is still a strong case for inflation protection, says Hooker. Namely, the question of whether anyone can really predict what’s going on. Consider the BoE’s so-called ‘Rivers of Blood’ chart below, which lays out the Bank’s own forecasts of where price rises might go. Here we can see that whereas the ‘corridor of uncertainty’ in 2006 was on a relatively manageable scale of between +1% and +3%, today that range has expanded to a far more challenging 0% to +5%.
Figure 2: Rivers of Blood? The changing shape of Bank of England inflation forecasts
Source: Bank of England
Says Hooker: “We live in uncertain times and the Bank of England itself has admitted that its own inflation forecasts have been wide of the mark. That’s with 80 economists working full time researching inflation. If even the BoE with all its expertise and resources can be so uncertain about the future direction of travel then what hope is there for us mere mortals? Now more than ever we believe it makes sense to have some kind of inflation protection in place.”
For Professional Clients only. Any views and opinions are those of the investment manager unless otherwise noted. For further information visit the BNY Mellon Investment Management website. INV00994 Exp 28 Dec 2017.
Evaluating performance, Bank of England, November 2015